Illinois Bond Spreads Explode As Market Pukes On Latest Batch Of Bad News

Tyler Durden's picture

On June 1, first S&P the Moody's almost concurrently downgraded Illinois to the lowest non-Junk rating, BB+/Baa3 respectively, with both rating agencies warning that the ongoing legislative gridlock and budget crisis need to be resolved, or else Illinois will be the first ever US state downgraded to junk status.

S&P analyst Gabriel Petek explicitly warned that "the unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments" and warned about Illinois' inability to pass a budget for the past two years amid a clash between the Democrat-run legislature and Republican Governor Bruce Rauner. As we have documented previously, the ongoing confrontation has left the fifth most-populous US state with a record $14.5 billion of unpaid bills, ravaged entities like universities and social service providers that rely on state aid and undermined Illinois’s standing in the bond market, where investors have demanded higher premiums for the risk of owning its debt.

Bypassing its traditional 90-day review, a terse S&P also warned that Illinois will likely be downgraded around July 1, when the new fiscal year begins if leaders haven’t agreed on a budget that starts addressing the state’s chronic deficits.

Unfortunately for Illinois, and its bondholders, the downgrade - and the subsequent imminent "junking" - was just the tip of the iceberg.

As Bank of America wrote in its latest muni market report, among the $14.7bn backlog of bills (as of 5 June) to be paid by the state of Illinois due to the protracted budget impasse is some $2bn-plus in Medicaid-related payments owed to the private insurers the state contracted with to manage roughly two-thirds of its Medicaid recipients. Those payments amount to some $300mn per month. A number of private insurers have sued in U.S. District Court for the Northern District of Illinois to prioritize their payments over those due to other vendors.

Then last Wednesday, following the Illinois downgrades, the court ruled against the state. The judge ordered the parties to "continue to negotiate to achieve substantial compliance with the consent decrees in these cases. If they cannot reach a negotiated solution, either party may make an appropriate motion, to be noticed for presentment on June 20, 2017."

The day before the court ruled, the state submitted a filing with the Court, arguing that should the court prioritize those payments - effectively making them on par with so-called "core payments" which include debt service - it could trigger another downgrade from the rating agencies. Indeed, included in Moody's downgrade report under the headline "Factors that could lead to a downgrade," Moody's points to "[c]ourt rulings that increase the volume of payment obligations that are legally prioritized."

The state asked the court in that filing that, if it were to rule against the state and prioritize those Medicaid payments, that it make its order effective 1 July, requesting so for two reasons:

  • It "likely will avoid an immediate downgrade and also would send a message to the Illinois General Assembly and Governor that they have until June 30 to resolve the State's budget impasse and avoid the consequences of the Court's order. If the budget impasse is not resolved by July 1, that fact alone likely will lead to a rating downgrade, regardless of the effective date of the Court's order."
  • It "will give Defendants some additional time to determine how to comply with the Court's order."

Additionally, the Illinois Comptroller warned against an adverse ruling, saying the state would "have to go to the courts and ask them: 'OK, out of all of these court-mandated payments, which ones am I allowed to violate?'"

With all that, the court still ruled against the state saying that the Court said it believes the Comptroller "faces an unenviable situation," though it finds "that minimally funding the obligations of the decrees while fully funding other obligations fails to comply not only with the consent decrees, but also with this court's previous order."

So for anyone confused, here is a summary of what happened: a judge ruled last Wednesday the state is violating consent decrees and previous orders, and instructed the state to achieve "substantial compliance with consent decrees in these case." The order may prioritize those payments, elevating them to the level of "core payments," such as for debt service. The state has warned that could trigger an immediate downgrade from Moody's. The state asked the court that the order become effective on 1 July as it could pressure the state to end its protracted budget impasse.

* * *

Separately, there was a glimmer of hope for the woefully underfunded state: according to the Illinois Commission on Government Forecasting and Accountability's (CGFA) May Monthly briefing, May net revenues of $2.19bn were up $144mn, or 7.0% compared to the same month a year ago. Personal income tax collections performed well during the month, bringing in $1.17bn, $179mn, or 18.1% more than in April 2016. Sales tax collections also performed well, outperforming April 2016's collections by $36mn, or 5.5%. However, the state's other significant revenue stream - the corporate income tax - underperformed, with collections of $81mn coming in $72mn, or 47.1% less than a year ago.

And while April marks the third consecutive month of Y/Y outperformance, a glimmer of sunshine in an otherwise dready Illinois monetary landscape, the recent burst in receipts is likely a fluke especially since fiscal year-to-date collections of $26.54bn are $955mn, or 4.3% behind last year. The culprit: local businesses, as corporate income tax collections have been the main cause under-performance, falling $909mn, or 41.3% on a year-over-year basis.

What happened next? As Bank of America writes, with bondholders still digesting the recent downgrades and the inevitable downgrade to junk, news of the adverse court ruling caused spreads on Illinois' GOs to blow out. As of last Thursday, the month-to-date spreads on Illinois widened by 69bps, surging just shy of 250 bps as the market absorbed the headlines. Then according to Bloomberg, the OAS on Illinois 5% GO due Mah 2015, soared nearly 40 bps since last Thursday.

The chart below shows how the spreads have moved wider each day since the month began. On Thursday the spread widened out by 28bps, compared to average 8.2bps it moved the previous five days. Since then the move has accelerated.

Finally, Reuters today reported that Illinois appears to have essentially thrown in the towel on getting junked,  and has negotiated lower credit rating termination triggers for its interest-rate swap deals with banks, "which stood to pocket fat fees if the state is downgraded to junk as soon as next month, a spokeswoman for the governor's office said on Monday. "

Eleni Demertzis, the governor's spokeswoman, said the rating levels that would trigger the termination of four swaps - two with Barclays Bank, and one each with Bank of America and JP Morgan - were dropped a notch to the second level of junk - BB with S&P or Ba2 with Moody's.

Without this step, downgrades to the first level of junk by S&P or Moody's Investors Service could have forced the cash-strapped state to pay the banks as much as $39 million in fees to end the swaps, according to the Illinois Comptroller's office.

In short, while Illinois won't be punished with higher swap termination costs when the downgrade to junk hits, all other negative side effects of being the first "fallen angel" state in history will remain, chief among them far higher borrowing costs.

* * *

And while the recent blow out in spreads has been nothing short of stunning for the otherwise sleepy muni market, a far bigger problem awaits both Illinois, which faces substantially higher borrowing costs, and bondholders, whose principal losses are starting to hurt, if the state fails to pass a budget for the third consecutive year and is downgraded to junk. A default is also not out of the question.

Traditionally, sharp moves in the bond market - such as thise one - have been sufficient to prompt politicians to reach a compromise, although in a world in which central banks have always stepped in to make things better, we fail to see how or why the Illinois auto pilot, which is currently set on collision course with insolvency, will change direction any time soon.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Give Me Some Truth's picture

That's probably not much of an exageration. Another story on ZH a few days ago noted how a pack of cigarettes in Chicago have gone from 35 cents a pack to $11/pack in about 40 years. And that's without hyperinflation, which is coming  (a lot sooner than in 40 years).

Ban KKiller's picture

Obama is not moving back for many reasons, millions. Ooops....Billions. 

Herodotus's picture

Why doesn't the court order the banks to garnishee the state's bank accounts in order to pay the creditors?

Dickweed Wang's picture

Why doesn't the court order the banks to garnishee the state's bank accounts in order to pay the creditors?


The rules are much different at the State level as opposed to a personal or corporate insolvency.

youngman's picture

Just default will more kicking the can....and with the default you can sell new crap..and GS will say buy it....

montresor's picture

Couldn't have happened to a better state..

venturen's picture

I just love that Obama delivered Illinois to the grave. Democrats are destroying any reason to EVER vote for them! Of course there are always the McCains of the world that claim one thing but are another...but watching CT and IL in death spiral isi heart warming

They had a banner weekend in Chicago 43 shot...6 month end they will be over last year's record!

Manipuflation's picture

Just talked to a buddy who lives in CHI.  Not good.  It's a war zone.

Dickweed Wang's picture

It's a war zone.


Yes indeed . . . and the bastards running Chicago make it extremely hard for a law abiding person to get and carry a firearm (of course those same assholes go nowhere in the city without an armed escort).

jazznoir's picture

Venturen -

There's a website that tracks Chgo shootings and murders.  As of right now June 12, Chgo has 281 for the year. 30 this month.

Half-year June 30 of 2016 closed at 331.  Politicians are praying for the under.  It'll be close.

Blazing in BC's picture

...death spiral isis heart warming, fixed it for you.

HRH Feant2's picture

What does Illinois have to sell? Any nice state park land? State-owned buildings? State-owned art?

For the people that think they are going to keep drawing a check I hope they diversified their income streams and have a back up plan. Eating cat food doesn't sound like my idea of a fun retirement.

Dickweed Wang's picture

Eating cat food doesn't sound like my idea of a fun retirement.


Fucking A . . . you know who's going to take it up the ass on this don't you?  The retirees/pensioners in that commie state - that's who.  You can also be assured that the TBTF Banks will get their cut (likely close to 100 cents on the dollar) before anyone else gets theirs.

Lumberjack's picture

I'm seeing a lot of 'now broke' towns and cities in Ma.. this is going to be really bad. Uncle Obama pissed it all away (into the wind) and now keep an eye out for union big wigs and such to start fleeing the country.

Blankenstein's picture

The taxpayers have been taking it all along.  Screw the Illinois state government pensioners.  They are the ones that voted for this shit, even though it was unsustainable and unrealistic.  Retiring in their 40s and 50s with almost full salary pensions.  Paid for by those with lower salaries and without pensions for the most part.  Not going to work.  Then they leave Illinois for retirement because it is too expensive. 

Hell, the property taxes in Illinois are the 2nd highest in the nation, yet they are in last place for solvency.  Amazing.

$100k salary elementary school teachers who work 9 months of the year and fire hydrant flushers who make $70k a year and both have golden pensions and great insurance to boot.


Lost in translation's picture

You're describing CA police retirees to perfection.

After 30 years of confiscating guns discovered in the trunk of some poor soul's car, and putting college kids in prison because a single, 30-round AR mag was found laying in the back seat at a DUI checkpoint, these "heroes" retire to AZ at 52 with 100% pay, there to preach to others, "I moved here for my Second Amendment rights, California is tyranny!"

whatamaroon's picture

Cat food is too boney, dog food digests better :)

sister tika's picture

Soon there will many more states on their fiscal death bed. Illinois is just the first domino. This state deserves everything they (don't) 'get'.

yogibear's picture

The sooner the better. All those arrogant teachers, fireman and cops pointing to the state constitution.

Manipuflation's picture

Does anyone here even own an Illinios bond?  How would you buy one? 

Dickweed Wang's picture

Does anyone here even own an Illinois bond?  How would you buy one?


Only under extreme duress . . .

whatamaroon's picture

GM pension funds? All those TBTF banks issue those bonds, knowing full well us taxpayers will pay er back them up. I am sure Trump would be glad to hep out./

mary mary's picture

Maybe Illinois will give whatever billionaire owns the Bears another few hundred million dollars for a new football stadium.  "Civic pride!"

Herodotus's picture

Does Illinois have any debt-financed vehicles subject to security agreements?  Have the lenders repossessed any of the state's vehicles yet?

Dickweed Wang's picture

. . . . we fail to see how or why the Illinois auto pilot, which is currently set on collision course with insolvency, will change direction any time soon.


Ms. Illinois?  Meet Mr. Detroit . . .

silvercity's picture

And to the average citizen of Detroit, what bad actually happened? Did the average citizen lose money on their bonds? Did their pensions get cut?( most Detroit pensioners live elsewhere) Nothing bad happened to Mr.Average Detroit

Scuba Steve's picture

You realize Detroit is not a state, right?


silvercity's picture

I do realize that in governments that cannot print or issue money, there is very little difference.

mary mary's picture

I think you can consider yourself a citizen of a city.  At least if you live in and pay taxes to that city.

Give Me Some Truth's picture

Does anyone still live in Detroit?

hooligan2009's picture

but but but..Emmanuel says Chicago is a "safe space" for all criminals!!!

surely this applies to bankrupts all the way up to the state level as well!

rlouis's picture

The bond holders must feel a little Ill-annoyed, it sounds just a little more appropriate than being Purteo Ricoed.

Stormtrooper's picture

It looks like Illinois is going to teach Peurto Rico how to stiff their creditors by repudiating their debt as a sovereign state.  Or, how to ignore their status as a sovereign state and become the first US Greece (better get your guns back citizens of Illinois).

yogibear's picture

Blow up and go bankrupt already!

Vardaman's picture

At some point, the voters have to be enjoined from voting for "more of the same."   Yeah, yeah, it'll never happen.  Barring that, a law that prevents federal bailouts for cities or states needs to be put in place.  Better yet, a constitutional amendment stating same.  Again, yeah, yeah, it'll never happen.

Lost in translation's picture

Two, mildly off-topic questions I have, are:

1. How long until CA does the same thing?

2. WHO bought CA bonds in the first place!? I have never met, or even heard of, anyone so doing.

Scuba Steve's picture

your teachers union did and oh yeah, that fund that your 401k manager peddles ... you know the one you've never heard under the guise of "Stable Fund" ....

These bonds are in there, dont kid yopurself they are in there. Packaged in the right traunches. nice and neat just like the 2007 mortgages.

Lost in translation's picture

I'm not union in my position (we don't have one), but I hear ya'.

youngman's picture

and they are being bought today..because.welll..look at that return...woww

cheech_wizard's picture

Sound familiar?

Michael Burry found out these mortgage bonds that we supposedly 65% AAA were actually mostly full of shit, so now he’s going to “short” the bonds, which means to “bet against.” Got it? Good.

imapopulistnow's picture

Can someone explain to me what is going through their minds? Are they so math illiterate as to not understand the consequences? Have they accepted the whole thing is not fixable and are just milking it to the end? Both?

gregga777's picture

They are busy lining their pockets while the entire state government collapses into insolvency around them.  There are still a lot of bribes to rake in by continuing to do favors for CONporate and other interests even as the state collapses into bankruptcy.  

Not My Real Name's picture

You mean there are still corporations in Illinois? I thought they all left awhile ago because they could no longer afford to pay the taxes required to bail out the politicians who have been lining the pocket of state government employees via ridiculous pay scales and six-figure government pensions. 

mark3383's picture

the connected corporations get gigantic exemptions, Google Sears on that regard for Fs sake

silvercity's picture

Totally correct. And why should Il pols do otherwise? It is past the point of being fixed.

Mr.BlingBling's picture

Dude, this is, by far, the most lucrative part of the ride! Think how much a corrupt pol can skim from desperate State vendors that haven't been paid in years. "Sure, I can get you paid next month--if you make it worth my while."

Fuckin' Blagojevich is probably banging his head on his cell's bars in frustration that he's on the sidelines.

Kprime's picture

mamma always said, "stupid is as stupid does".